The Fed acknowledges “uncertainty and risks present in the inflation outlook”

FXStreet (Mumbai) - The minutes of the US Federal Reserve’s December 15-16 meeting was published yesterday. The Fed had in its December meeting raised the interest rates from record low levels for the first time in a decade, thereby ending its zero rate regime. The Fed had declared it will hike rates 25 bps four times in 2016. It had stressed that the subsequent rate hikes will be gradual and data dependent.

The minutes confirmed the FOMC definitely sees inflation rising to its 2 percent target over the medium term. However, it also highlighted some FOMC members during the meeting had flagged the risks related to achieving inflation target. The minutes mentioned the “significant concern about still-low readings on actual inflation” as well as the “uncertainty and risks present in the inflation outlook,” the minutes said. The FOMC therefore felt the need to closely assess the progress of inflation to ensure inflation was rising in the expected manner. ‘In light of the current shortfall of inflation from 2 per cent, the Committee will carefully monitor actual and expected progress toward its inflation goal’, the minutes stated.

The minutes also drew attention to other downside risks to inflation such as shock from oil prices and continuous rise in dollar. It is also feared that the strengthening in labor market will not be sufficient to offset the impact of the persistent global disinflationary forces.

Can the Fed pull off four hikes in 2016?

The Fed, as mentioned earlier has expressed its intention to hike rates four times this year to just below 1.5%. Traders in futures markets however see the Fed raising rates just twice by year-end, to just under 1 per cent. According to Roberto Perli, an analyst at Cornerstone Macro “They will probably end up doing less than they think”. Federal Reserve Vice Chairman Stanley Fischer feels the market is underestimating the number of times the Fed will increase rates in 2016. John Williams, president of the San Francisco Fed said he could “easily see” three to five rates hikes this year.

The headwinds cannot be completely discounted. Inflation has remained below the Fed’s 2% goal for almost 3½ years now. This persistently low inflation signifies signify that there exists underlying weakness in overall economic activity. There are risks that might slow down the pace of the economic recovery. The strength of the US dollar might continue to restrict export growth. The recently released ISM PMI that shows steady decline in manufacturing sector. The global economy continues to remain weak. The recent release of Chinese indicators has further heightened the fear of slowing down of the world’s second largest economy. Given that economic indicators have not been too impressive lately, analysts revised down their estimates of Q4 GDP growth. Macroeconomic Advisers, a forecasting firm revised its estimated down to less than 1 per cent from near 2% in mid-December. These factors might restrict rate hikes to just two in number for this year as against four rate hikes intended by the Fed.

“nearly all” of the Fed officials at the December meeting were confident that inflation would pick up once unemployment rate fell and the economic slack ebbed. Prior to the December meeting the Fed had said it would not hike unless it was “reasonably confident” that inflation would move up to its target.

The minutes explained “Although almost all [officials] still expected downward pressure on inflation from energy and commodity prices would be transitory, many viewed the persistent weakness in those prices as adding uncertainty or imposing important downside risks to the inflation outlook”.

Backing its decision to support a gradual increase in rates, the minutes said “Gradual adjustments in the federal funds rate would also allow policymakers to assess how the economy was responding to increases in interest rates.”
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